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The U.S. economy is clearly in a modest recovery, but obvious fears are still suppressing business investment, including IT spending. Underlying these concerns are opposing sets of competitive fears, which are motivating companies to stoke the spending fires. The key question: Which of these fears will prevail? It will all come down to one thing: the STINKO Factor.

What Can We Expect in 2004?

AMR Research Inc.’s latest spending survey of more than 100 Fortune 500 decision-makers says that IT spending in 2003 will grow a paltry 0.22 percent. In other words, it will be flat with 2002 spending. This level of spending means that there is little to no room for new projects; flat spending means simply maintaining current projects. This is not good news for new vendors that depend on new license revenue. Within these numbers, 24 percent of respondents say they plan to increase spending this year, and 27 percent are planning for decreased spending. This says that what growth there is will come from a small, select group of companies (about one in four) that are using the downturn to build competitive advantage through selective investment in new, strategic IT initiatives.

Macroeconomic data is fairly consistent with our survey. It is positive, although the outlook is for only very moderate growth, with clear caution in the numbers:

The U.S. government just reported the fifth straight quarter of GDP growth. Even though the Q402 was barely positive–1.4 percent growth, driven largely by an 11 percent increase in military spending amid shrinking consumer confidence–current forecasts are for 2.5 percent growth in this first quarter.

Business investment, which has shown negative growth since Q400, has been trending upward since the first quarter of last year (its low point) and was in positive growth territory for the first time in two years in Q402. All indications are that this will continue on a positive course.

Software and IT spending, as a subset of business investment, have been positive for several quarters, although there was no fourth-quarter budget flush, as the numbers were barely positive.

Corporate profits, which are necessary for increases in IT spending, went positive for the durable manufacturing sector (the hardest hit sector of the economy) in the middle of 2002 and continue to progress. Note that the durable manufacturing sector was in the red throughout 2001 and barely positive until the middle of last year.

Net-net, this macroeconomic data says that the U.S. economy is in recovery and fighting to sustain it. After two years of disinvestments, this makes sense, so why don’t our surveys show more confidence and indicate growth rather than a flat line? The answer is STINKO.

The Rising Sun Is Hidden Behind a Cloud of STINKO

STINKO is an acronym for the puzzling anomaly that exists in the market. It represents five elements:

– Scandal

– Terrorism

– Iraq

– North Korea

– Oil

The U.S. economy is clearly in recovery; few can argue this point. However, while corporate governance issues are abating (Scandal), the geopolitical situation (TINKO) is keeping a lid on consumer and business spending. Consumer confidence is at a 10-year low, and the corporate spending refrain remains: “We bought more technology than we needed through 2000 and the fact that we haven’t spent in two years hasn’t hurt us. With all that’s going on in the world, we’re not starting again now.” This is all for good reason, because if the worst fears from STINKO occur, we are looking at plummeting consumer confidence and decreased trade, resulting in decreased profitability, another likely recession, and another downturn in business investment. So why take a chance? There is only one reason: competitive fear.

Geopolitical Versus Competitive Fear

Fear of competitive disadvantage is in direct conflict with the pressures of STINKO. As I stated earlier, the best companies are not standing still through this downturn. They are taking advantage of a buyer’s market to invest in performance improvement. The opportunities are compelling if you look at the business cases for initiatives targeting procurement and strategic sourcing, Product Lifecycle Management (PLM), supply chain efficiency, demand and revenue management, and business intelligence.

This is a time when the market leaders will use their profits to increase their leads and position themselves to run faster than their competitors when the downturn turns up. As our survey indicates, 27 percent of companies are increasing spending or initiating new projects, with companies like Wal-Mart Stores Inc., Microsoft Corp., Maytag Corp., General Electric Co., and General Motors Corp. cited as examples.

This fact puts competitive pressure on companies to lift the lid on spending so they don’t put themselves at a competitive disadvantage. Psychologically, fear is a much bigger motivator than opportunity. As the corporate profit picture continues to improve, fear of falling behind is the wild card that could spur spending beyond current projections. What is putting this competitive fear in check is the geopolitical situation (TINKO). So anything that puts STINKO behind us (a decisive military victory, an assured peaceful settlement, a decisive takedown of Al Qaeda, or such) will put the economy in full rebound. However, short of something decisive, I believe that we will continue to see a schizophrenic recovery based on these competing competitive and global fears.

The Vendor Markets? Modest Growth and Land of the Giants

Whatever happens, this is a slow growth recovery for the High-Tech sector, which clearly favors the larger players. The CFO is in charge and will be for some time to come, which means decisions with the least risk will reign. It’s no surprise that we’ve seen better-than-expected performance from market leaders like IBM Corp., SAP AG, PeopleSoft Inc., and Dell Computer Corp. while small players continue to struggle.

For example, in the enterprise applications market, we believe that the market will grow from about US$35 billion in 2002 to close to $50 billion in 2006. The beneficiaries of this growth will be the large Enterprise Resource Planning

(ERP) vendors like SAP, Oracle, and PeopleSoft, which will serve growing demand for strategic applications for sourcing (7 percent CAGR), PLM (13 percent CAGR), and supply chain management (6 percent CAGR). We expect the market shares for ERP vendors in each of these areas to grow considerably in the next few years. Large IT services firms, like IBM and Accenture Ltd., will also benefit. The result is bad news for most of the smaller vendors.

The fact remains that too many companies were funded in 1999 and 2000, and there is no market for them to serve. Venture capitalists have made it clear that there will be no second or third rounds for these companies, and Wall Street has completely dropped coverage of thousands of firms that went public during the bubble; these venture-backed private and small cap public firms have been left to die. Like it or not, we will see many more casualties and much more vendor consolidation. This will give the perception that a recovery is stalling, but it is actually inconsequential to the general health of the market.

Recovery Will Accelerate Through 2003, Yielding Sustained Growth in 2004

In 1999, New Economy mavens wrongly pronounced that we would never see another downturn in IT spending. Now, I too often hear that we will never again see a robust technology market. This too is myopic and wrong. The corporate profit picture continues to improve, and after two years of neglect, business investment is on the rise, portending a healthy recovery. As long as the geopolitical situation doesn’t worsen, the recovery should accelerate through 2003, and the U.S. economy should be humming again in 2004. As this happens, we will again see strong and increasing spending on new technology. Note that this recovery does not mean returning to the irrational exuberance of the late 1990s, when a combination of Y2K and dot-com fever surged spending to unnaturally high levels. However, it does mean reasonable and steady growth. For example, we do see the overall enterprise applications market pushing back toward 10 percent annual growth.

For those who don’t believe, I’ll bet you that in 10 years we will laugh at how primitive our technology was in 2003. That says that between now and then there will be massive new spending on technology and innovation. When will this new spending start? I’d love to give you the day and time. But first, we have to deal with STINKO.